This year’s Laureate is awarded the Prize for his research on international trade and economic geography. By having shown the effects of economies of scale on trade patterns and on the location of economic activity, his ideas have given rise to an extensive reorientation of the research on these issues.

Traditional Foreign Trade

In the early 1800s, the English economist David Ricardo launched the theory of so-called comparative advantage to explain the range and composition of international trade….

…Over the last half century, however, researchers observed increasingly large deviations
from the trade patterns predicted by Ricardo. So-called intra-industry trade has expanded, in particular between rich countries. Such trade implies that a country both exports and imports more or less the same goods. A country such as Sweden, for example, exports and imports cars…

  • Almost 30 years ago, Krugman introduced an entirely new theory of international trade. It was intended to explain the occurrence of intra-industry trade and was based on an assumption of economies of scale whereby mass production diminishes the cost per unit produced.
  • Consumers Appreciate Diversity: In addition to economies of scale in production, Krugman’s new theory was based on an assumption that consumers appreciate diversity in their consumption.
  • Economic geography deals not only with what goods are produced where, but also with the distribution of capital and labor over countries and regions. The approach Krugman used in his foreign trade theory – the assumption of economies of scale in production and a preference for diversity in consumption – was also found to be appropriate for analyzing geographical issues.
  • What would happen if foreign trade became impossible, for instance due to excessively high transport costs or other obstacles. If two countries are exactly alike, then welfare will be the same in both countries. But if the countries are alike in all respects except that one of them has a slightly larger population than the other, then the real wages of labor will be somewhat higher in the country with more inhabitants. The reason is that firms in the more highly populated country can make better use of economies of scale, which implies lower prices to consumers and/or greater diversity in the supply of goods. This, in turn, enhances the welfare of consumers. As a result, labor, i.e., consumers, will tend to move to the country with more inhabitants, thereby increasing its population. Real wages and the supply of goods will then continue to increase even more in that country, thereby giving rise to further migration, and so on. Firms’ location decisions imply a trade-off between utilizing economies of scale and saving on transport costs.
  • core-periphery model, which shows that the relation between economies of scale and transport costs can result in either concentration or decentralization of communities.

P.S.: There is lots to be discussed about the core-periphery model…soon.

Here is the prize anouncement.

Here is the Charlie Rose interview dated 10/23/2008: